Revealed Preference Theory, Introduction and Graphical Representation
Doorsteptutor material for competitive exams is prepared by world's top subject experts: get questions, notes, tests, video lectures and more- for all subjects of your exam.
Revealed Preference Theory: Theory of demand; Introduction and Graphical Representation (Economics)
Introduction
- Propounded by Paul Samuelson
- Ordinal utility analysis
- This theory analyses preference for a combination of goods on the basis of observed consumer behavior in the market.
- The demand theorem given by Samuelson, also known as the Fundamental theorem of consumption theory, states that a commodity that is known to have an increased demand when the income rises must have a decrease in demand when there is a rise in its price.
- In other words, when income elasticity of demand is positive, price elasticity of demand is negative.
Choice Reveals Preference
- This theory of demand is based on the revealed preference hypothesis which states that choice reveals preference.
- According to this theorem, a consumer buys a combination of goods because of two reasons:
- Either the consumer likes the combination more than the other combinations even if it costs more,
- Or the combination is cheaper than the other combinations.
Graphical Representation
Assumptions
- If a consumer chooses a combination, he reveals his preference for that combination.
- Tastes and preferences of the consumer are constant
- A consumer always prefers a combination with more goods than a combination with less goods.
- Only one combination is chosen at a given price-income line.
- Based on strong ordering.
- If A is preferred to B in one situation, combination B cannot be preferred to A in another situation. Therefore, the consumer is consistent in his behavior. This is called two-term consistency.
- If combination A is preferred to B, and B is preferred to C, then A is assumed to be preferred to C. This is known as transitivity or three-term consistency.
- The income elasticity of demand is positive, that is, when the income of the consumer rises, he demands more of the commodity and vice-versa.
Demand Theorem in Case of Rise and Fall in Price
- We will now analyze the demand theorem in two cases:
- when price rises,
- and when price falls.
- We will assume that there are two commodities, X and Y.
Rise in Price
Fall in Price
Mcqs
Q.1. Who propounded the revealed preference theory?
- Milton Friedman
- Paul Krugman
- Paul Samuelson
D. Kenneth Arrow
Answer: C
Q.2. When income elasticity of demand is positive, the price elasticity of demand is:
A. Negative
B. Positive
C. Not correlated
D. None of the above
Answer: A
Q3. Which of the following is an assumption of the revealed preference theory?
A. A consumer will always choose a combination with less goods as opposed to a combination with more goods.
B. If a consumer chooses combination X in one situation, he may choose other combinations such as Y or Z in other situations.
C. If combination A is preferred to B and B is preferred to C, combination A is assumed to be preferred to C.
D. The income elasticity of demand is negative.
Answer: C
Q.4. . Revealed preference theory assumes
A. Weak ordering
B. Strong ordering
C. Constant ordering
D. Multiple ordering
Answer: B
#NET
#UGCNET
#ECONOMICS
#REVEALEDPREFERENCETHEORY
✍ Manishika